Gainesboro Machine Tools Corporation

Introduction – Company background Dividend payment decisions Policy analysis

◦ Zero dividend payout – pros and cons◦ 40% or $0.2 per share – pros and cons◦ Residual-dividend payout – pros and cons

Conclusion

Agenda

Founded in 1923

In early days, it has designed and manufactured a number of

machinery parts, including metal presses, dies and molds. By 1975, it

has evolved as innovative producer of industrial machinery and

machine tools.

In 1980, entered in CAD/CAM and established itself as industry leader

Aggressive entry of large foreign firms damped sales

The recent restructuring has improved efficiency and development of

Artificial Workforce. System.

The company is expected to have good growth in future

Company background

For three years in a row since 2000, dividends had

exceeded earnings

In 2003, dividends were decreased to a level below

earnings

Despite losses in 2004, small dividend was declared

It has not paid dividend in 2005 although it had committed

earlier to pay sometime in 2005

Dividend history

Dividends is considered as a yardstick of a company's prospects

Typically, mature, profitable companies pay dividends If a company with a history of consistently rising dividend

payments suddenly cuts its payments, investors should treat this as a signal that trouble is looming

Steady or increasing dividends is certainly reassuring, investors are wary of companies that rely on borrowings to finance those payments

Holding onto profits might lead to excessive executive compensation, sloppy management, and unproductive use of assets

Dividend payment decisions

There are three main factors that may influence a

firm's dividend decision:

◦ Free-cash flow

◦ Dividend clienteles

◦ Information signalling

Factors influencing dividend decisions

The firm pays out, as dividends, any cash that is surplus

after it invests in all available positive net present

value projects.

It does not explain the observed dividend policies of real-

world companies

Most companies pay relatively consistent dividends from

one year to the next and managers tend to prefer to pay a

steadily increasing dividend rather than paying a dividend

that fluctuates dramatically from one year to the next

The Free Cash Flow Theory

A particular pattern of dividend payments may suit one type of

stock holder more than another

A retiree may prefer to invest in a firm that provides a

consistently high dividend yield, whereas a person with a high

income from employment may prefer to avoid dividends due to

their high marginal tax rate on income

A key criticism of the idea of dividend clienteles is that

investors do not need to rely upon the firm to provide the

pattern of cash flows that they desire. An investor who would

like to receive some cash from their investment always has the

option of selling a portion of their holding.

Dividend clienteles

Stock prices tend to increase when an increase in dividends is

announced and tend to decrease when a decrease or omission

is announced

Managers have more information than investors about the

firm, and such information may inform their dividend decisions,

which is considered as an indication of firm’s health

As managers tend to avoid sending a negative signal to the

market about the future prospects of their firm, this also tends

to lead to a dividend policy of a steady, gradually increasing

payment.

Information signalling

Strength• Value Line rated it as an “A” Company• Recently restructured• Artificial workforce• They are expanding

Weakness• Top line and bottom-line are falling• Dividends are not being paid• Very conservative

Opportunity• World market• New technology innovation• JV’s and acquisitions

Threat• Macroeconomic environment is not

conducive • New and big players are entering the market • Market shock• The competitors are catching up

SWOT

SWOT ANALYSIS

What would be the most strategic, efficient and effective move that the management of Gainesboro should take in managing the firm’s equity that will not distort the stockholders and assures the company’s future.

Central Problem

Pros◦ It’s a growing company and needs the plough

back the retained earnings ◦ Borrowing for dividend can be avoided ◦ Can be positioned as high growth and high

technology firms ◦ More and more companies are not paying

dividends◦ Cash flow will be positive by 2007

Zero dividend

Cons◦ Commitment!◦ Value oriented investors(13%), Long-term

retirement people(26%) they need dividends

◦ DPS fallen from 1.03 to near zero Stock brokers have a negative sentiments

Zero dividend

Pro’s ◦ Inline with expectation◦ 0.8$/share , the highest since 2001◦ Show positive sign of confidence ◦ Inline with growth◦ Will stay within the 40% debt/equity ratio

Will increase by 10%( a total of ~ 20%)

40 percent dividend

Con’s◦ Unnecessary increase in debt◦ Growth company needs to plough back◦ 15% growth is too optimistic ◦ Positive cash flow will be happen only in 2011,

else in 2007 itself! Even with a 15% growth

◦ If the growth is 10%

40 percent dividend

Projections

2005 2006 2007 2008 2009 2010 2011

Excess cash $

(30.4) $ (25.3)

$ (23.1)

$ (24.7)

$ (18.1)

$ (25.7)

$ (12.0)

Pro’s◦ Giving back only excess retained earnings

Con’s ◦ Dividend may not be constant

The company’s image might be hampered

Residual dividend payout

Borrowing

Issuing New Shares

Funding

Pro’s◦ Will instill confidence

In turn increase the share price ◦ Increase EPS◦ Reduce the dilution

Con’s◦ As of now they have to take debt to buy back

shares

Repurchase

Pro’s◦ Will increase the brand awareness◦ Might increase share price◦ Long term intangible asset

Con’s◦ Is it required now ?◦ Its not proven, its speculative ◦ High cost

Corporate image advertising

Need to restore confidence and need to be growth oriented ◦ They need to pay dividend or repurchase of stock

Paying dividend is better◦ With 40% the cash flow will become positive only

in 2011◦ But with 30% it will happen in 2009 itself!

Its also safe(10% -20% growth should accompany a dividend of 30%-50%)

Its in sync with the industry average

Suggestion

Implement Zero-Dividend Payout Approach◦ Maximize Excess Cash for future projects◦ Provides Ample Cash for Expansion & Investment◦ Flexible to minimize interest expense & dividend

expense which negatively impact its net income goals

Recommendation

Thank You